Off-balance Sheet Activities Research Articles

Estimating a Bayesian stochastic frontier for the Indian banking system

This paper employs a Bayesian stochastic frontier, providing exact inference on both cost and profit efficiencies of the Indian banking sector in the period of 2000–2006. We also test for the inclusion of off-balance sheet data in model specification. The findings suggest that public banks are the most efficient, followed by private and foreign banks. However, the latter largely improved profit efficiency, outperforming domestic banks by the end of the sample. Accounting for off-balance sheet activities significantly improves profit efficiency levels.

Bank Liquidity Creation, Monetary Policy, and Financial Crises

Monetary policy efficacy depends largely on how it affects bank behavior. Recent events have cast doubt on how well monetary policy works in this regard, particularly during financial crises. In addition, issues have been raised about the role of banks in creating asset bubbles that burst and lead to crises. In this paper, we address these issues by focusing on bank liquidity creation, which is a comprehensive measure of bank output that accounts for all on- and off-balance sheet activities. Specifically, we formulate and test hypotheses that address the following questions: (1) How does monetary policy affect bank liquidity creation during normal times? (2) Does monetary policy affect bank liquidity creation differently during financial crises versus normal times? (3) Is high aggregate bank liquidity creation an indicator of an impending financial crisis? We have three main findings. First, during normal times, monetary policy affects liquidity creation, but only for small banks. Second, the effects of monetary policy are weaker for banks of all sizes during financial crises than during normal times. Third, liquidity creation tends to be high (relative to trend) prior to financial crises and has incremental explanatory power in predicting crises even after controlling for other macroeconomic factors.

Developing Sound Banks in Transitional Economies: Structural Reforms in Ukraine

This paper explores the methods that the Ukrainian government (supported by international technical assistance providers) is developing to minimize the probability of a damaging, systemic banking crisis. The contention is that with highly lucrative existing sources of income for banks receding (and profits under increasing pressure), banks will more aggressively expand their balance sheets - but not necessarily in a healthy manner - as well as engage more in riskier off-balance sheet activities, such as foreign exchange trading. Thus, in the coming period, the fragility of the Ukrainian banking system could increase, leaving the system at greater risk. The first two sections briefly review banking under the Communist system, and in the first period of the transitional governments. Then follows an in-depth discussion of Ukraine which explores at some length some of the elements needed for a more comprehensive strategy. An appendix deals with the question of banking sector strategy in more general terms.

Efficiency and productivity of Greek banks in the EMU era

We provide a characterization of the Greek banking system's efficiency and productivity under the new environment that the Economic and Monetary Union (EMU) participation implies. We consider cost and profit efficiency as well as productivity change of commercial banks using the nonparametric Data Envelopment Analysis (DEA) and the Total Factor Productivity (TFP) Malmquist Index. The period under study is 1998-2003 covering Greece's entry into the euro area in 2001 and the run-up to it. Moreover, enhanced competition along with lower inflation and interest rates has further motivated financial innovation and Off-Balance Sheet (OBS) business. Our findings suggest that cost efficiency has risen by 4.3% over the 6 years under study. Moreover, Greek banks seem to enjoy relatively high profit efficiency (on average 75%) showing an increase by 93% over 1998-2003. Similarly, productivity seems to have risen by 15% and this was mainly driven by the improvements in the performance of best-practice institutions. Our results do not show any role for OBS activities in Greek banks' efficiency. Finally, while the impact of profitability and size on efficiency and productivity yields mixed results, our empirical findings seem to corroborate previous studies in that controlling for risk preferences is important in determining bank efficiency.

Income-Generating Efficiency of Public Sector Banks in India: An Application of Data Envelopment Analysis

This paper accomplishes the task of examining the inter-bank differentials in income-generating efficiency across 28 Public Sector Banks (PSBs) operating in India during the financial year 2006-2007. The technique of Data Envelopment Analysis (DEA) has been used to compute the efficiency scores for individual PSBs. The empirical findings reveal that PSBs are generating net-interest and non-interest incomes with high level of efficiency which is reflected by the mean efficiency score of 0.918. The study suggests that for improving their performance, the inefficient PSBs should concentrate more on generating non-interest income from the off-balance sheet activities (i.e., nontraditional activities) rather than interest income from the traditional activities like advancing loans and investments in other earning assets.

The consideration of Off-Balance Sheet activities on banking efficiency and productivity performances within the UAE

Despite overall growing profits and increasing Total Factor Productivity (TFP) change in the United Arab Emirates banking sector, research reveals evidence of over-banking and inefficiency by the sector as a whole and several banks in particular. The inclusion of Off Balance Sheet (OBS) activities increases efficiency scores and estimated productivity levels for most banks, reinforcing the prevailing view that the exclusion of non-traditional activities leads to a misspecification of banks' output.

Economic Consequences of Recognizing Off-Balance Sheet Activities*

This study investigates the economic impact of FASB Interpretation No. 46, Consolidation of Variable Interest Entities (VIEs) - an Interpretation of ARB No. 51 (FIN 46). FIN 46 requires firms to consolidate VIEs, often referred to as special purpose entities (SPEs), if certain criteria are met. I find that the adoption of FIN 46 is associated with both a decline in the use of VIEs and an effort by firms to decrease book leverage by substituting conventional debt with equity. This evidence indicates that the new rule affects firms' capital structure decisions. Moreover, I demonstrate that Standard & Poor's credit ratings for VIE firms have significantly worsened since the adoption of FIN 46. The change in credit rating indicates that FIN 46 conveys new information that was not previously incorporated into credit ratings. I also find that the pricing of information risk decreased for non-VIE firms, but not for the VIE firms. Taken together, the evidence is consistent with the stated goal of FIN 46, which is to enhance the representational faithfulness of financial statements in circumstances where the risk and benefits of ownership are retained.

Financial structure change and banking income: A Canada–U.S. comparison

Data suggest that the Canadian financial structure, and particularly indirect finance (e.g., banking), have become more market-oriented. We associate this financial trend in part with the regulatory changes that have occurred in Canada since the 1980s. Financial intermediaries are increasingly involved with financial market activities—e.g. off-balance sheet (OBS) activities such as underwriting securities. In this article we analyze the noninterest income attributable to these financial market activities. We find that the variance of Canadian banks’ aggregate operating-income growth is rising because of the increased contribution of noninterest income. Overall, our analysis corroborates the U.S. findings of Stiroh and Rumble (Stiroh, K., 2006. A portfolio view of banking with interest and noninterest assets. Jounal of Money, Credit, and Banking 38, 1351–1361; Stiroh, K., Rumble, A., 2006. The darkside of diversification: the case of U.S. financial holding companies. Journal of Banking and Finance 30, 2131–2161): by contributing to banking income volatility, market-oriented activities do not necessarily yield straightforward diversification benefits to Canadian banks.

Estimating the technical and scale efficiency of Greek commercial banks: The impact of credit risk, off-balance sheet activities, and international operations

This paper uses data envelopment analysis (DEA) to investigate the efficiency of the Greek commercial banking industry over the period 2000–2004. Our results indicate that the inclusion of loan loss provisions as an input increases the efficiency scores, but off-balance sheet items do not have a significant impact. The differences between the efficiency scores obtained through the profit-oriented and the intermediation approaches are in general small. Banks that have expanded their operations abroad appear to be more technical efficient than those operating only at a national level. Higher capitalization, loan activity, and market power increase the efficiency of banks. The number of branches has a positive and significant impact on efficiency, but the number of ATMs does not. The results are mixed with respect to variables indicating whether the banks are operating abroad through subsidiaries or branches.

An Empirical Analysis of the Off-Balance Sheet Activities of Indian Banks

The article traces the determinants of off-balance sheet activities in the Indian banking sector. Using data for the period 1996 to 2004, the article finds that not only regulatory factors, but also market forces captured by banks-specific characteristics and macro-economic conditions are at work in the diffusion pattern of off-balance sheet (OBS) activities. From the regulatory standpoint, while capital adequacy is dominant in the case of public sector banks, non-performing assets seem to he a prime concern for foreign banks, in addition to public sector banks. Among others, at the bank-specific level, size is an important consideration for public sector and foreign banks, while profits are a prime mover only for new private banks. Finally, the macro-economic environment seems to have played an important role in affecting OBS diffusion, more so for public sector and new private banks.

Competition in Hong Kong's Banking Sector: A Panzar-Rosse Assessment

A re-examination of the competitive conditions of the banking industry in Hong Kong, based on the Panzar-Rosse approach and using a panel dataset with longer time-series data, reconfirms previous findings in our RM 04/2004 that the degree of competition was fairly high during the period 1992-2002. The empirical analysis also suggests that competitive pressures have been maintained in subsequent years, notwithstanding significant changes in the operating environment. The estimation results showed that competitive pressures were higher among larger banks and lower among smaller banks. This may suggest that while larger banks compete with smaller banks keenly in local retail markets on products such as mortgages and credit cards, they may be subject to even stronger pressures from other competitors at the regional or international levels in the corporate banking market, wealth management and other off-balance sheet activities, where they are more heavily involved. While relaxation of regulations and advances in technology tend to increase competition in the banking system, the effect of consolidation may depend on the prevailing market settings. To the extent that bank consolidation in recent years may have hampered competition, regulatory liberalisation and technological progress appear to have largely offset the adverse effect. The emergence of a number of larger banks through mergers and acquisitions which should be more capable of competing with existing large banks may have also contributed. Nonetheless, with bank consolidation expected to continue, how market concentration may impact on competition in the years to come needs to be closely monitored.

Off-balance sheet activities and cost inefficiency in Taiwan's Banks

In this study, we adopt a stochastic cost frontier method to investigate the influence of off-balance sheet (OBS) activities on the cost efficiency of Taiwan's banks. We estimate and compare cost inefficiency with or without OBS outputs of 46 Taiwanese commercial banks during the period, 1998 through 2001. The conclusions of this empirical study are as follows. First, omitting off-balance sheet outputs in estimating the cost frontier function of banks results in an underestimation of bank efficiency by approximately 5 per cent. Second, large banks are associated with a higher cost efficiency and have an increased ability to develop OBS activities. This is consistent with Taiwan's regulatory policies, which focus on promoting efficiency in the banking industry of emerging markets. Banks with higher employee productivity are also more cost efficient. Finally, we observe evidence of economies of scale in both models with or without OBS specification in Taiwan's bank industry. Economies of scope between loans and OBS outputs are also observed.

Incentives for consolidation of finance subsidiaries: evidence from France

The focus of this study is to improve understanding of the incentives underlying a particular type of off-balance sheet financing: the non-consolidation of finance subsidiaries. We examine a sample of French firms that had finance subsidiaries during the 1990–1997 period. More than 32% of these firms did not consolidate their finance subsidiaries during the period studied. This contrasts with Anglo-American countries where established GAAP have eliminated the non-consolidation option. The direct consequence of not consolidating these highly leveraged subsidiaries is the reduction of debt-to-capital ratios. As suggested by economic theory, results show that firms are less likely to consolidate their finance subsidiaries the higher their level of indebtedness, the larger their size, the greater their ownership concentration and the larger the extent of their credit activities. The predictable results support the moves to limit exception to consolidation and to increase disclosure with respect to off-balance sheet activities.

Off-balance-sheet credit risk of the top 20 Japanese banks

The study of off-balance-sheet (OBS) credit risk across the top 20 Japanese banks indicated that financial derivatives were heavily used by the top four banks and that loan commitments are the largest source of credit risk among traditional OBS instruments. The notional amounts of derivative contracts make up 92 per cent of total OBS activities. There is a wide difference across the banks in the use of derivative leverage. As compared to the US and European banks, Japanese banks use fewer OBS instruments as a percentage of their assets. This implies that Japanese banks are more conservative and risk averse in general than their US or European counterparts, especially given the bad financial condition of the banks and Japan.

Off-balance-sheet credit risk of the top 20 European commercial banks

The comparison of off-balance-sheet (OBS) credit risk of the top 20 European commercial banks indicated that loan commitments are the largest source of credit risk among traditional OBS instruments. However, the notional amounts of derivative activities make up around 95 per cent of the total OBS exposure. Here, a concentration of exposure with a small group of banks can be found. An analysis by country of origin points to national differences in the use of derivative leverage. In comparison with US commercial banks, European banks use fewer OBS activities as a multiple of on-balance-sheet assets. The disclosure and reporting by European banks regarding OBS activities varies widely and is less comparable than US activities.

Market Discipline of Canadian Banks' Letters of Credit Activities: An Empirical Examination

While the motivation and riskiness of US off-balance sheet banking activities have been studied both theoretically and empirically, no such study has been found dealing with Canadian off-balance sheet banking activities, although such activities are numerically huge, and growing larger each year. This article provides support for a market discipline hypothesis of Canadian bank letters of credit activities by employing several market measures of risk from one-factor and multi-factor models, and an implied asset volatility from the option-pricing model. Furthermore, it examines both price and quantity response of off-balance sheet activities in the Canadian banking market by employing a tobit analysis to assess the robustness of our conclusions about market discipline. The results indicate that various market measures of risk and letters of credit are negatively related. Moreover, banks with greater portfolio risk measured in terms of equity and asset risk, high leverage and interest rate risk are less likely to issue letters of credit.

International capital standards, bank portfolios and bank stock risk

The results suggest that the composition of bank portfolios affect the market risk (beta) of bank stock returns. In particular, the 20% asset category, which primarily includes government agency securities is associated with increases in market risk, indicating assets in this category are exposed to higher interest rate risk and prepayment risk. The market risk is lower for those institutions who concentrate on one-to-four family residential mortgages, suggesting home mortgages are well collateralized assets with low perceived credit risk. The off-balance sheet activities on average exhibit no significant impact on market risk. The results also suggest that the market perception of the insurer's expected liability is heavily influenced by Tier 1 capital ratio.

Trends in Book-Tax Income and Balance Sheet Differences

We use Compustat and tax return data to describe trends from 1991-1998 in differences between book and tax measures of income and balance sheet amounts. Our primary findings confirm that book-tax income differences are growing throughout the 1990s. Extending prior work, we partition the sample to describe the differences by industry, global character and profitability. Secondly, we compare Compustat financial statement assets and liabilities to the book balance sheet reported on the tax return and find that the tax return amounts exceed the financial statement amounts in the aggregate. We plan to investigate suggested explanations for this excess, including differences in book versus tax consolidation reporting and off-balance sheet activity.

X-Efficiency in Banking: Looking beyond the Balance Sheet

The distribution free and stochastic frontier estimation methods are used to derive bank specific measures of cost and profit Xefficiency. This is done to investigate the importance of including aggregate measures of off-balance-sheet (OBS) activities. The results indicate that economic cost and production cost X-efficiency estimates increase with the inclusion of the OBS measure. Profit Xefficiency estimates are largely unaffected. Further, the composition of banksO OBS activities appears to help explain interbank differences in cost and profit X-efficiency estimates, whereas bank size and the mix between on- and off-balance-sheet banking activities are largely uncorrelated with the X-efficiency estimates.

The X-Efficiency of Commercial Banks in Hong Kong

This paper uses the stochastic econometric cost frontier approach to investigate the cost efficiency of commercial banks in Hong Kong. On average, the X-efficiency of Hong Kong banks is found to be about 16 to 30 percent of observed total costs, which is comparable to the findings in the U.S. banking industry. X-efficiency is found to decline over time, indicating that banks in Hong Kong are now operating closer to the cost frontier than before. This is consistent with technological innovation that might have occurred in the Hong Kong banking industry. Furthermore, the average large bank in Hong Kong is found to be less efficient than the average small bank, particularly during the earlier time periods. Finally, X-efficiency is found to be related to certain bank characteristics. Specifically, X-efficiency is found to decline with bank size, deposit-to-asset ratio, loan-to-asset ratios, provision for loan loss, and loan growth, and to increase with off-balance sheet activities.